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Eurozone Headed for Japan-Like Deflation?

17 Years ago | June 04, 2014 10/1/22, 12:00 AM

We heard an economist a couple of days ago on business TV talking about the deflationary spiral developing in the Eurozone. He said it was not the same, but it was similar to Japan. He said the problem with several nations in Europe were the same as in Japan. That was too much debt. He said that Japan, which has a massive debt to GDP ratio has survived only because of its deflation which drove interest rates to low enough levels that it was able to service its debts. He worries now that the government wants to drive Japanese inflation to 2.0% while 10-yr JGB’s pay only 0.60%. Do the math.  2.0% inflation and a 0.60% yield on bonds is going to lead to a heavy capital outflows, with negative implication (not unwanted) in the JPY.

As for the Eurozone, He said there are only three solutions to too much debt. They are called the three D’s: Devaluation, Default and Deflation. Nations locked into the Eurozone do not have access to devaluation, and as a practical matter are not going to be allowed to default. That leaves “deflation” as their only viable approach to economic stability. The politically correct term for this in Europe is an “internal devaluation”. That means lowering the standard of living (wages, costs, etc.) to the point where the economy becomes competitive. One problem with this approach is that the social safety-net gets in the way of this brutal adjustment process. So we see 20%+ unemployment levels in some countries with a youth unemployment rate in some cases in excess of 50%.

Bottom-line, there is no quick fix to the problems within the Eurozone. The problems are structural and are not going to be fixed by ECB policies.

John M. Bland

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